Bonds promise attractive yields again. Inflation is falling faster than expected in many countries, creating favourable conditions for the global cycle of rising interest rates to come to an end. For investors who are not risk averse, high-yield bonds in particular are an interesting alternative.
This asset class comprises bonds from issuers with comparatively poor ratings. As their default risk is higher, they offer a correspondingly higher return. In addition to the current generally high interest rates, issuers of high-yield bonds have to offer hefty risk premiums to provide investors with compensation for the increased risk of default. In the case of Scandinavian high-yield bonds, for example, this risk premium, known in trade terms as the credit spread, is currently around 200 base points higher on average than in the USA and Europe. Investors therefore receive around two per cent more return for the same credit risk on Nordic bonds than in the USA and the rest of Europe.
However, investors should bear in mind that part of the higher interest rate obtainable with high-yield bonds may be needed to cover the losses of those companies that are no longer able to make up their deficits. Net losses of around one per cent of the portfolio per year are common in markets such as the USA. In times of pronounced economic weakness, they can quickly double.
Higher yields than the long-term average
In addition, it can be difficult to obtain fresh capital on the market for high-yield bonds in periods of market volatility. This could make it more difficult to sell bonds at favourable prices - and result in higher fluctuations in bond prices.
On the other hand, these bonds usually recover relatively quickly when the markets calm down. Interesting fact: Unlike shareholders, however, bondholders have an entitlement that they can enforce in court if necessary. Even in the event of bankruptcy, bondholders are usually still able to claim a residual value.
Investors are being very well compensated for the underlying risks in the current environment. The most important aspect from an investor's point of view is certainly the attractive yield premium. This currently averages around 200 base points higher than high-yield bonds with comparable credit risk in the USA and the rest of Europe. In addition, investors are currently able to realise significantly higher returns than global high-yield bonds have generated on a long-term annual average.
DNB Fund High Yield vs. Benchmark
Equity-like returns with lower risk and lower volatility
Against this backdrop, Scandinavian high-yield bonds represent a promising market. The Nordic economies are efficient and well-positioned, the yield premiums on high-yield bonds are attractive - and interest rates have probably already experienced their steepest rise.
It is often very difficult for private investors to access this segment, as it is easy to make the wrong decisions without in-depth knowledge of the creditworthiness of issuers and the macroeconomic factors that influence the high-yield market. Here, funds not only offer the advantage of a diversified investment, but also the opportunity to achieve equity-like returns with lower risk and reduced volatility.
In recent years, a correlation between risk and potential returns has emerged. Despite the declines during the pandemic and during the oil price slump in 2014 and 2015, the DNB High Yield A fund, for example, has performed significantly better than Norwegian investment grade funds. In the event of a mild economic recovery, a return of eight per cent per annum is possible.
As it can take one or two years for a fund to recover after major drops in value, these investment portfolios are best suited for investors with a relatively long investment horizon, preferably longer than three years.